The ‘Fiscal Cliff’ Misdirection

By David Waddell

Please recognize that the “fiscal cliff” debate will not end with current compromise. This debate has just begun so get used to it. Our long-term fiscal situation is toxic and entirely a function of Medicare and Medicaid. Today, Medicare and Medicaid expenditures approximate 5 percent of U.S. GDP. According to the Congressional Budget Office, public health expenditures will rise to over 10 percent of U.S. GDP by 2037.

Total federal spending, not including interest payments, as a percentage of GDP will rise from 22 percent today to 26 percent in 2037. Therefore, mathematically, the entire increase in projected government spending can be attributed to increases in public health care costs. Now, add to those increases the burden of escalating interest expenses and federal government expenditures by 2037 become 36 percent of our economy.

Therefore, to break even and eliminate deficits, the government must increase taxes accordingly. The highest tax receipt total the government has been able to extract from the economy, as a percentage of GDP, was 21 percent in 1944 to subsidize the war effort. Today, tax receipts equal 15 percent of our economy. The long-term tax receipt equilibrium rate for the U.S. is 18.5 percent of GDP. Is more than doubling today’s tax level possible?

President Obama suggests that increasing taxes on the wealthy will “put us on a sustainable fiscal path.” There are roughly 4 million Americans earnings more than $200,000 per year. Their total taxable income approximates $2 trillion. Therefore taxing 100 percent of income for the “rich” would produce $2 trillion, or 14 percent of GDP. If we eventually need to increase taxes by 21 percent of GDP … that helps a lot.

Of course, the rational “rich” will not allow all of their income to be taxed. To demonstrate, in 2010 the United Kingdom increased taxes on millionaires from 40 to 50 percent. Prior to the tax increase, 16,000 Brits filed with more than $1 million in income. One year later, post-tax increase, the number dropped to 6,000. In 2010, pre-tax increase, British millionaires paid $13 billion in taxes. In 2011, post-tax increase, they paid $6.5 billion. Higher rates on the rich in Britain led to less tax revenues. In response, they are now lowering the millionaire rate!

This situation has also occurred in France with the implementation of their 75 percent millionaire tax. Millionaires are emigrating in droves, and corporations are having difficulty recruiting top level executives into France. The truth is, as Art Laffer has taught all of us, millionaires will NOT pay more in taxes. They have the resources to relocate, reclassify and reinvent. As we discussed last week, the campaign in Washington against the top 2 percent correlates more with reducing our country’s income inequality than it does with solving our fiscal problem.

Bottom line: Any discussion about “fiscal sustainability” that does not begin and end with Medicare and Medicaid is not a discussion about “fiscal sustainability” … it’s something else.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.